Eichengreen: Europe’s Crisis Treadmill

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May 15th, 2014

Barry Eichengreen points out the ongoing risk factors facing the euro area here.

Inside Europe’s Plan Z

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May 15th, 2014

Part 2 of the FT series covers GREXIT issues:  required reading here.

Irish budget speeches in the 21st Century

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May 14th, 2014

At last week’s Irish Economic Association conference, Mark Coughlan presented a paper analysing the text of successive Finance Ministers’ budget speeches, as evidence of shifts in policy emphasis, but also in the political economy and management of boom and bust economics. The slides are here and are worth a look.

Housing supply and demand

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May 13th, 2014

There is quite a bit of momentum currently – and thankfully, given the severity of the housing crisis – in the whole area of housing, rising prices and rents, and the lack of supply in Ireland’s urban centres. I had thought pretty much everyone involved was agreed that a lack of supply was indeed the root cause of rapidly rising rents and prices.

Hence my despair at reading this article in today’s Irish independent: Easy mortgages for first-time buyers are on the way. Shifting out demand to encourage supply seems to me to be like adding fuel to the fire in the hope that the fire brigade are more likely to turn up. The losers will be the very people the policy aims to help, first-time buyers who will be given more credit to bid against each other.

What is particularly disheartening is that it comes so soon after Ireland tried this before and it went so spectacularly wrong – while house price growth from 1995-2001 was driven by a combination of factors (including incomes growing faster than supply), house price growth 2001-2007 was driven almost exclusively by easy credit and that was where the damage was done.

As per last night’s Prime Time, if you want housing to be affordable, increase supply – it’s no more complicated than that. If supply is not forthcoming, we need to understand why, rather than push the price of housing further up. My suspicion is the current lack of supply is down to a complicated and overly prescriptive system of planning and building controls, coupled with an array of developer contributions and levies which shift the burden from existing to new residents. This could be replaced with a unified land use policy and a simple land value tax.

As for policy in relation to loan-to-value, pick a number (like 80%) as the maximum loan-to-value for anyone and stick with it. That way at least, policy won’t be responsible for turning a house price upswing into another bubble.

How the euro was saved

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May 12th, 2014

Peter Spiegel launches a special FT series that looks back at 2011-2012 with this article.

An intellectual winter

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May 12th, 2014

TheJournal.ie reports on a speech given by President Higgins at the University of Chicago this evening.

PRESIDENT MICHAEL D Higgins has told students at the University of Chicago that the teaching of economics is going through “an intellectual winter” because it doesn’t take account of the social impacts of policy.

“The recent economic and financial upheavals have thrown a glaring light on the shortcomings of the intellectual tools provided by mainstream economics and its key assumption regarding the sustainability of self-regulating markets (and, more particularly, of largely unregulated global financial markets),” he told the assembly.

The prepared text for the speech is available on the President’s website.  A recording of the actual delivery and subsequent Q&A session is available here.

Call for Abstracts: The 11th Irish Society of New Economists Conference 2014

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May 12th, 2014
The J.E. Cairnes School of Business and Economics, National University of Ireland, Galway  (NUIG) is delighted to host the 11th Irish Society of New Economists (ISNE) Conference from the 4th to 5th of September, 2014. The deadline for online submission of abstracts (not exceeding 300 words) is 30th May, 2014. There will be two Plenary Sessions featuring distinguished academics: Professor Ciaran O’ Neill (NUIG) and Professor John FitzGerald (ESRI).    
  
See here for further details.
We look forward to meeting you in NUI Galway.

 

The Local Organising Committee:  
Ms. Michelle Queally, NUIG
Ms. Aine Roddy, NUIG
Ms. Patricia Carney, NUIG
Dr.  Aoife Callan, NUIG

The Economic Rationale for the Insolvency Service of Ireland

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May 11th, 2014

The economic rationale for the new Insolvency Service of Ireland is well-founded in economic theory. It hinges on the concept of Pareto improving bargains. The idea is that a debtor, with the guidance of a personal insolvency practitioner, can construct a Pareto improving bargain to everyone’s benefit: the debtor, the lender, and society as a whole.

Consider a debtor with unsustainable debt who, to avoid the personal and social costs of bankruptcy, goes to a personal insolvency practitioner (PIP). The PIP objectively examines the debtor’s situation and suggests a payment scheme which offers only part-repayment of loan value. Let the offered proportion of loan value be denoted by OFFER where OFFER < 1.  If OFFER = 1 then the debtor is not insolvent since he/she can afford full-value payment and the PIP has no role.  The PIP describes the offered repayment plan to the lender (or lenders).

The lender knows that the alternative to a personal insolvency plan is bankruptcy for the borrower, and that bankruptcy entails large financial costs, most of which will be borne by the lender. The uncertain proportion of loan value received by the lender after accounting for bankruptcy costs will be denoted by RECOVER.  The debtor will accept the PIP offer if it provides higher expected value of total payments:

OFFER > E[RECOVER],          (A)

where E[ ] denotes the expected value.

The economic rationale for this process is that it can make all three interested parties (debtor, lender, and society) better off. The debtor avoids the personal/social costs of bankruptcy; the lender gets a loan recovery amount which is higher than the expected bankruptcy-cost-adjusted amount received otherwise.  Society avoids administrative bankruptcy costs and gets the benefits of a debtor freed more quickly from debt distress. Of course the PIP has lots of other duties (counselling the debtor, dealing with multiple lenders, administrative duties) but dealing with equation (A) is very fundamental.

The banks understand equation (A); the politicians understood equation (A) when they set up the enabling legislation. Does anyone in the Insolvency Service of Ireland understand equation (A)?  It is fundamental to the Service performing its important task competently.

The Primetime news show recently highlighted a young couple whose PIP offer was rejected.  I do not want to focus particularly on the individual case, keeping in mind the adage “hard cases make bad law.” According to the discussion in the show, the couple owed a mortgage-related debt of €276,000 and their PIP constructed an alternative loan repayment of €2,000. That is, relying on the numbers as discussed in the show, they made an offer of:

OFFER = 2,000/276,000 = 0.0072.

It is important for clarity to note that this does not denote a concessionary interest rate of 72 basis points; rather, 72 basis points is the total proportion of repayment including all principal repayment. Unsurprisingly, the PIP offer was rejected by the lender.

One could argue that the bank could just forgive the couple the loan debt as a gift (skip the 0.0072 partial payment which is too miniscule to consitute a meaningful debt settlement arrangement).  That is, the insolvency system can be brought in as a useful component of parish pump politics, in the good sense, of parish pump politics as using the political system to create unfunded sources of benefits for local causes.  There is certainly a case for doing this, but it was not actually the intention of the legislation. Doing so would greatly increase the effective political power of the ISI as controller of this new source of unfunded social benefits.

A technical feature of equation (A) is a convexifying effect for OFFER proportions close to zero. OFFER is known with certainty whereas RECOVER is a random proportion. Since RECOVER has a lower bound at zero, Jensen’s inequality means that the expected value of RECOVER is much higher than its maximum likelihood value in the region near zero. Is seems extremely difficult to create a scenario where E[RECOVER] could fall as close to zero as 0.0072.

The head of the Insolvency Service of Ireland was on the Primetime show, but he did not seem to be familiar with equation (A), or did not consider it relevant. He did seem to understand that if the ISI had the power to force deals without worrying about (A), then parish pump political considerations would give the agency much greater power. Yet equation (A) was extremely relevant and the absence of any appropriate analysis associated with it detracted considerably from the clarity of the discussion. The staff at the Irish Insolvency Service could benefit from the 30-minute lesson in the economic rationale for their agency’s existence.

[I added a few edits to correct typos, respond to comments (thanks to Sarah Carey and to other commenters who induced me to think more carefully). There may be some time-inconsistencies between the earlier comments below and the later edits.]

NYT: Review of Swing

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May 6th, 2014

It was a pleasure to read the very positive review of  Fishamble’s Swing (co-written by regular contributor Gavin Kostick and currently at the Irish Arts Center in New York, together with Beowulf) in the New York Times: here.

Mody on European QE

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May 6th, 2014

Mody writes here.

Labour Markets During Crises Conference

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May 6th, 2014

The Labour Economics Group at NUI Maynooth is hosting a one-day conference on Labour Markets During Crises on Wednesday, July 2 in Maynooth.

Olive Sweetman will be presenting our ongoing work on how the crisis has affected the Irish labour market, and we’ve got a great line-up of external speakers too: Torben Andersen from the University of Aarhus, Pedro Martins from Queen Mary College, University of London, Mike Elsby from the University of Edinburgh and Ignacio Garcia Perez from Seville’s Universidade Pablo de Olavide. Full details are available here.

As it says on the flyer, registration is free, but you should email me if you plan to attend.

IMF: Ireland—Concluding Statement of the First Post-Program Monitoring Discussion

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May 5th, 2014

Available here.

Jason Furman at IIEA

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May 2nd, 2014

The chair of the CEA will speak at the IIEA next Wednesday: details here.

Scots should recall the poverty of the Irish Free State

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May 2nd, 2014

“A nationalist state has carved itself out of the UK before. It was a disaster” writes Kevin Toolis in the FT: article here.

Problematic Calibration of the EU Banking Sector Stress Test for Ireland

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May 1st, 2014

The details for the calibration of the EU-wide bank stress test are now available. Looking only at Ireland, and only at one of the key variables in the stress test, the calibration looks problematic. It may be coincidental that the Irish adverse scenario has been badly chosen; it might be that all the other member countries have reasonable calibrations.  If the others are as problematic as in the Irish case, this is not a reliable EU banking sector stress test.

Under the adverse scenario, Irish property prices are assumed to suffer a cumulative three-year drop of 3.03%; equivalent to a decline of 1.02% each year for three years in a row. Over the period covered by CSO data, 2005-2013, Irish residential property prices had an annual sample volatility of 11.7%. This in turn implies (under reasonable assumptions) a three-year volatility of 20.27%. In risk analysis it is conventional analytical shorthand to measure adverse outcomes in “x-sigma” units defined as the outcome as a multiple of the standard deviation. For an adverse scenario calibration, the assumed outcome is usually roughly a two-sigma or three-sigma event. Using a four-sigma shock would not be unusual (due to fat tails in some probability distributions). The EBA has calibrated the adverse price shock as a 0.1492-sigma event. That is not credible as an adverse scenario in a stress test.

Keep in mind that the stress test is meant to reassure market participants that even in an adverse scenario the Irish banks are sound. This test reassures us that if property prices fall by as much as one percent a year over the next three years, the banks have enough capital. In the case of a two-percent fall, there are no promises.

As a caveat, this does not mean that the Irish banks need equity capital. They have already had a credible stress test (in 2011) and a big capital injection. Also, the Irish property market although very volatile has a maximum likelihood price change which is positive over the next three years. However the asset class also has considerable “downside” potential and continued high volatility. Conventionally, at least in the case of portfolio risk analysis, the unconditional mean of a stressed variable is set equal to zero for risk analysis purposes. The EBA has chosen to build in a big positive benchmark price rise for Irish property assets, and this is part of the reason that the adverse scenario is unacceptably mild. In any case, this calibration is extremely mild as an adverse scenario and not reassuring for the EU-wide test.

Invitation: Dublin Launch of Legrain Book

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May 1st, 2014

All are welcome at the Dublin launch of Philippe Legrain’s “European Spring: Why Our Economies and Politics are in a Mess – and How to Put Them Right” on Tuesday 6 May at 1800h, the launch to be by Senator Sean Barrett at the Long Room Hub in TCD.

For a flavour of Philippe’s book, read his article on the eurozone’s flawed crisis response in the international edition of the New York Times.

The Independent has also published an exclusive extract from the book.

European Spring is available on Kindle for £2.99  and for £10.16 in paperback.

Long run Irish fiscal data

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April 30th, 2014

From NUIG’s Dr Aidan Kane, a (really) long run data set covering Irish fiscal data from 1690 to 1800. This work has been decades in the making and is the first of a series of releases connecting Ireland’s fiscal history to its modern, post establishment of the CSO era. Dr Kane’s new website, Duanaire, has the details.

To get a sense of the level of resolution of the data, take a look at the chart below. Congrats to Dr Kane and let’s hope this resource is used by researchers into the future.

Inversions, deferral and the US tax code

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April 30th, 2014

An earlier post  linked to today’s FT piece on inversions and other tax strategies.  The following is an amended comment to that post.

Ebay’s 8-K SEC filing made yesterday for Q1 2014 has some interesting outcomes that are related to some of the issues covered by the FT. The form is available here but all you really need is:

Non-GAAP earnings increased 11%, to $899 million or $0.70 per diluted share, over the prior year, driven by strong top line growth. A first quarter GAAP loss of ($2.3) billion or ($1.82) per diluted share, was due to a discrete tax charge of approximately $3.0 billion.

From the income statement it can be seen that Ebay’s effective tax rate for Q1 2014 was:

($3,199mn/$873mn) x 100 = 366%

The  $3 billion discrete tax charge was primarily because Ebay now intends to repatriate to the US around $9 billion of profits that were previously held ‘offshore’. EBay probably used versions of the ‘double-irish’ tax strategy to trigger a deferral of the US corporate income tax liability using subsidiaries in Luxembourg and/or Switzerland.

Tax payments such as this $3 billion will never appear in US BEA data on direct investment abroad by US MNCs as the tax payment is made by the US parent not the foreign subsidiary. The US BEA data only gives the corporate income tax paid by the subsidiaries outside the US. Under the current international tax regime most of the corporate income tax owed by these companies is owed on risks, assets and functions that are in the US (though the US offers extensive deferral provisions).  Effective tax rates based on this BEA data are a poor indicator of the actual tax rates as the US tax liability is not included.

This Ebay example is what is supposed to happen with tax deferral provisions such as the ’same-country exemption’ (which allows ‘double-irish’ type structures to work). Ebay could invest the money abroad free of making a US tax payment.   Alternatively it could choose to repatriate the profits to the US and the US corporate income tax payment up to the 35 per cent federal rate becomes due. This seems to be a case of this happening.

Apple with around $150 billion of retained earnings are going to return money to shareholders through a massive share buy-back but instead of repatriating offshore profits to do it are going to issue bonds to borrow the funds. If Apple does this outside the US it can ‘invest’ its retained earnings by repaying the bonds and the deferred US tax will not be paid.

Pfizer with $70 billion of retained earnings are going to use the money to buy AstraZeneca. This is fine from a US perspective and is what the deferral provisions are designed for – giving US companies interest-free loans to allow them to increase their non-US presence. The inversion to the UK that will come with the acquisition is not what the US wants and completely removes not only the retained earnings but the entire company from the US system.

The FT piece somewhat conflates the impact of inversions and the use of ‘double-irish’ type tax structures.  If a company inverts and re-headquarters to Ireland or the UK or any country it no can longer avail of the key benefits of a ‘double-irish’ scheme.  It can have the same corporate structure but the purpose of the ‘double-irish’ is to defer US corporate income tax by utilising the “same-country exemption” in Subpart F of the US tax code.  Under the “same-country exemption” passive income payments between two companies in the same country are not subject to the general anti-deferral provisions of Subpart F.

If a US company re-headquarters it is no longer a US company and therefore no longer subject to US corporate income tax on its global profits.  The “same-country exemption” becomes irrelevant as it only applies to US companies. 

The piece says the ‘double-irish’ “allows royalties paid by the Irish manufacturing subsidiary to end up in a company that is not taxable under either Irish or US rules.”  That is not correct.  The royalties are taxable under US rules but the ‘double-irish’  creates a deferral of the actual payment using US tax provisions until the profit is repatriated to the US.  In the case of Ebay we can see this repatriation and the triggering of the tax payment happening.

The US is more likely to act against the inversions than the deferral provisions. But even getting consensus on that may be difficult as Republicans will argue the inversions highlight problems with the US tax code and that it is the overall code which should be changed not the addition of roadblocks against inversions – the biggest of which seem to be to the UK not Ireland.

Finally, whatever is left of Pfizer’s retained earnings of $70 billion after the AstraZeneca acquisition will likely have a large once-off impact on UK GNP if the inversion does go ahead.

Philippe Legrain: Investors are ignoring eurozone risks

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April 30th, 2014

I generally agree with the main point made by Philippe Legrain in this FT article and I can also recommend his new book.  At the same time, it is unfortunate that he focuses on the recent GDP numbers for Ireland, given the well-flagged interpretation issues with the recent GDP data.

The Italian Economy

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April 30th, 2014

The WSJ provides a long-form account of the barriers to economic growth in Italy – here.

Tax avoidance: The Irish inversion

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April 29th, 2014

FT article here.

EBA publishes common methodology and scenario for 2014 EU-banks stress test

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April 29th, 2014

here.

International Financial Flows and Domestic Credit Conditions

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April 29th, 2014

In this short article in the Macroeconomic Review published by the Monetary Authority of Singapore, I review the connections between international debt flows and domestic credit: here.

Alan Ahearne: What’s driving the rapid property price rise?

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April 26th, 2014

Irish Times op-ed here.

Philippe Legrain on the need for a European spring

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April 25th, 2014

Here. The book on which the article is based is here.

European Solidarity Manifesto

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April 25th, 2014

Some time ago I posted a link to the proposals of the “Eiffel group”, which struck me as a logical contribution to the debate about the future of the Euro.

Here is another contribution to the debate which also strikes me as logical.

Programme Updates

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April 25th, 2014

We no longer get these for Ireland but the Commission has published its latest reviews of the Greek and Portuguese programmes.  The Greek review runs to 250 pages.  I didn’t go much beyond this table of macroeconomic forecasts

and this chart projecting Greek public debt to 2030.

Hmmm.

Martin Wolf: Money versus Banking

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April 25th, 2014

Martin Wolf addresses how money and banking can be separated in this FT article here.

The Power of Inaction: Bank Bailouts in Comparison

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April 22nd, 2014

In this new book, Cornelia Woll examines the political economy of bank bailouts in a variety of countries; it includes a comparison of Ireland versus Denmark.  More details here.

Evidence on the likely impact of the patent cliff

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April 21st, 2014

NUIM’s Chris Van Egeraat has posted some recently presented work responding to this Department of Finance working paper (.pdf) on the patent cliff, first brought to my attention, anyway, on this blog by Frank Barry.

Chris looks carefully at the actual products coming off patent and finds only one, Nameda, which is big enough to cause a wobble. As he notes, the amount of information is pretty poor in this area, so caveats remain.